EURUSD tumbled as Draghi sounds more pessimistic than expected coupled with the downgrade of German GDP growth

EURUSD is currently trading around 1.1305 in the US session Thursday, slumped by almost -0.65% on dovish hold by the ECB and as Draghi sounds more pessimistic than expected coupled with the downgrade of German GDP growth. EURUSD made a session low of around 1.1288, tumbled by almost -0.86%; earlier it made a session high of around 1.1398.

On Thursday, Draghi warned in his ECB Q&A opening statement “risks have moved to the downside” and urged quite vaguely for the Eurozone governments to “raise longer-term growth potential”; i.e. to use fiscal stimulus (structural reforms) as ECB is now almost out of weapons (monetary stimulus) to fight a looming recession.

Draghi said: "The risks surrounding the euro area growth outlook have moved to the downside on account of the persistence of uncertainties related to geopolitical factors and the threat of protectionism, vulnerabilities in emerging markets and financial market volatility. The persistence of uncertainties, in particular relating to geopolitical factors and the threat of protectionism, is weighing on economic sentiment”.

The market was surprised about Draghi’s high level of pessimism in an ECB meeting without fresh economic projection (less important policy meeting).

Draghi also pointed out: “Euro-area recession not seen as a likely event but the ECB can't exclude a more benign economic outcome. We see a rebound in German car sector as the slowdown in China unlikely to last long. TLTROS were mentioned by several officials, but the ECB didn't take a decision on TLTROS”.

Later in the Q&A, Draghi said “Today’s ECB meeting was devoted to an assessment on the slowdown and about the questions of ‘Where are we? Why we’re here? And how long will the slowdown last?’ The meeting was not about the implications of monetary policy. And ECB policymakers were unanimous on acknowledging weaker momentum and changing of the balance of risks for growth. The Governing Council will give itself more time to assess the risk factors, and there will be another discussion in March with new economic projections”.

Draghi added: “The underlying inflation has been muted, but confidence in the outlook is based on continued growth and strong employment. There is a profit squeeze and it's only a matter of time until it's passed through. We were unanimous in assessing the factors that caused the slowdown, namely the 'increasing general uncertainty' and the decision was unanimous about acknowledging weaker momentum. If risks persist, momentum will be weak for long. Key risks include the slowdown in China and waning US fiscal stimulus. But the likelihood of Eurozone recession is very low and we don’t believe a recession in Italy or Germany likely”.

Draghi continues: “The ECB has given itself more time to assess risks and the ECB has a full toolbox available. If we do TLTROs, there should be a monetary policy reason, but we don't want to be in the situation where lower rates aren't transmitted”.

More comments from Draghi’s Q&A: “The ECB will consider different contingencies and we don’t expect stock of Eurozone government bonds to increase in future. The pressure on rates (bond yields) will lessen by itself; liquidity will remain abundant into next decade”.

But EUR recovered to some extent as Draghi also noted: "When the market forecasted first rate hike in 2020...shows they have understood our reaction function”. These particular comments show that the ECB is willing to hike from Q1-2020 as per current market pricing, everything being equal, although it may be too late (delayed) “through summer-2019” (after August-2019). The ECB is also unwilling to use TLTROs as a policy tool right now and coupled with broad weakness in the USD/Dow at that particular time (due to the US commerce secretary Ross’ comments that the US is 'miles and miles' from a trade deal with China), EURUSD bounced back to some extent.

On Thursday, as unanimously expected, the ECB kept main refinancing rate unchanged at 0.00%. The forward guidance is also held unchanged. That is, “key ECB interest rates to remain at their present levels at least through the summer of 2019” and the ECB will continue to re-invest principal amounts from the matured bond for the foreseeable period-for an extended period of time after the first rate hike; i.e. the backdoor QE will go on for the time being.

Full ECB policy statement: Monetary Policy Decisions: (Unchanged from the last statement)

“At today’s meeting, the Governing Council of the European Central Bank (ECB) decided that the interest rate on the main refinancing operations and the interest rates on the marginal lending facility and the deposit facility will remain unchanged at 0.00%, 0.25% and -0.40% respectively. The Governing Council expects the key ECB interest rates to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term”.

“Regarding non-standard monetary policy measures, the Governing Council intends to continue reinvesting, in full, the principal payments from maturing securities purchased under the asset purchase programme for an extended period of time past the date when it starts raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation”.

“The President of the ECB will comment on the considerations underlying these decisions at a press conference starting at 14:30 CET today”.

Draghi’s introductory statement:

“Ladies and gentlemen, the Vice-President and I are very pleased to welcome you to our press conference. We will now report on the outcome of today’s meeting of the Governing Council, which was also attended by the Commission Vice-President, Mr. Dombrovskis”.

“Based on our regular economic and monetary analyses, we decided to keep the key ECB interest rates unchanged. We continue to expect them to remain at their present levels at least through the summer of 2019, and in any case for as long as necessary to ensure the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term”.

“Regarding non-standard monetary policy measures, we intend to continue reinvesting, in full, the principal payments from maturing securities purchased under the asset purchase programme for an extended period of time past the date when we start raising the key ECB interest rates, and in any case for as long as necessary to maintain favourable liquidity conditions and an ample degree of monetary accommodation”.

“The incoming information has continued to be weaker than expected on account of softer external demand and some country and sector-specific factors. The persistence of uncertainties, in particular, relating to geopolitical factors and the threat of protectionism is weighing on economic sentiment. At the same time, supportive financing conditions, favorable labor market dynamics, and rising wage growth continue to underpin the euro area expansion and gradually rising inflation pressures. This supports our confidence in the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term”.

“Significant monetary policy stimulus remains essential to support the further build-up of domestic price pressures and headline inflation developments over the medium term. This will be provided by our forward guidance on the key ECB interest rates, reinforced by the reinvestments of the sizeable stock of acquired assets. In any event, the Governing Council stands ready to adjust all of its instruments, as appropriate, to ensure that inflation continues to move towards the Governing Council’s inflation aim in a sustained manner”.

“Let me now explain our assessment in greater detail, starting with the economic analysis. Euro area real GDP increased by 0.2%, quarter on quarter, in the third quarter of 2018, following growth of 0.4% in the previous two quarters. Incoming data have continued to be weaker than expected as a result of a slowdown in external demand compounded by some country and sector-specific factors. While the impact of some of these factors is expected to fade, the near-term growth momentum is likely to be weaker than previously anticipated”.

“Looking ahead, the euro area expansion will continue to be supported by favorable financing conditions, further employment gains and rising wages, lower energy prices, and the ongoing – albeit somewhat slower – expansion in global activity”.

“The risks surrounding the euro area growth outlook have moved to the downside on account of the persistence of uncertainties related to geopolitical factors and the threat of protectionism, vulnerabilities in emerging markets and financial market volatility”.

“Euro area annual HICP inflation declined to 1.6% in December 2018, from 1.9% in November, reflecting mainly lower energy price inflation. On the basis of current futures prices for oil, headline inflation is likely to decline further over the coming months. Measures of underlying inflation remain generally muted, but labor cost pressures are continuing to strengthen and broaden amid high levels of capacity utilization and tightening labor markets. Looking ahead, underlying inflation is expected to increase over the medium term, supported by our monetary policy measures, the ongoing economic expansion, and rising wage growth”.

“Turning to the monetary analysis, broad money (M3) growth moderated to 3.7% in November 2018, after 3.9% in October. M3 growth continues to be backed by bank credit creation. The narrow monetary aggregate M1 remained the main contributor to broad money growth”.

“The annual growth rate of loans to non-financial corporations stood at 4.0% in November 2018, after 3.9% in October, while the annual growth rate of loans to households remained broadly unchanged at 3.3%. The euro area bank lending survey for the fourth quarter of 2018 suggests that overall bank lending conditions remained favorable, following an extended period of net easing, and demand for bank credit continued to rise, thereby underpinning loan growth”.

“The pass-through of the monetary policy measures put in place since June 2014 continues to significantly support borrowing conditions for firms and households, access to financing – in particular for small and medium-sized enterprises – and credit flows across the euro area”.

“To sum up, a cross-check of the outcome of the economic analysis with the signals coming from the monetary analysis confirmed that an ample degree of monetary accommodation is still necessary for the continued sustained convergence of inflation to levels that are below, but close to, 2% over the medium term”.

“In order to reap the full benefits from our monetary policy measures, other policy areas must contribute more decisively to raising the longer-term growth potential and reducing vulnerabilities. The implementation of structural reforms in euro area countries needs to be substantially stepped up to increase resilience, reduce structural unemployment and boost euro-area productivity and growth potential”.

“Regarding fiscal policies, the Governing Council reiterates the need for rebuilding fiscal buffers. This is particularly important in countries where government debt is high and for which full adherence to the Stability and Growth Pact is critical for safeguarding sound fiscal positions”.

“Likewise, the transparent and consistent implementation of the EU’s fiscal and economic governance framework over time and across countries remains essential to bolster the resilience of the euro area economy. Improving the functioning of Economic and Monetary Union remains a priority. The Governing Council welcomes the ongoing work and urges further specific and decisive steps to complete the banking union and the capital markets union”.

Overall, although Draghi is quite pessimistic about Eurozone growth basically on account of Trump trade war (China is a big trading partner of the EU), he is quite optimistic about the prospect of Eurozone wage growth and tightening labor market. Draghi/ECB believes that ultimately this wage inflation will transmit in the Eurozone core inflation and thus the ECB is expected to hike from Q1-2020 onwards.

Draghi actually is now preparing the market for delayed rate hikes from previous forward guidance (“through summer-2019); i.e. after August-2019 and the market will now focus on ECB’s new economic projection in March, where it could officially shift the forward guidance language from “summer-2019” to “winter-2019” or even “spring-2020”.

Talking about delayed normalization, ECB has actually no other options as the overall Eurozone economic data continues to surprise on the downside amid lingering US-China Trump trade war and Brexit saga.

On Thursday, flash data shows that the German manufacturing PMI for January tumbled below the boom/bust line of 50 to 49.9 from prior 51.5, lower than the expectations of 51.4. The German service PMI for January surged to 53.1 from prior 51.8, better than the expectations of 52.2. The German composite PMI for January surged to 52.1 from prior 51.6, higher than the expectations of 51.9.

For the Eurozone, the manufacturing PMI for January slumped to 50.5 from prior 51.4, weaker than the expectations of 51.5. The service PMI for January slips to 50.8 from prior 51.2, weaker than the expectations of 51.5. The composite PMI for January tumbled to 50.7 from prior 51.1, weaker than the expectations of 51.4 and the lowest in 66-months. Both the Eurozone manufacturing as-well-as service PMI is now in stagnation.

For Germany, although the manufacturing was in contraction, the composite PMI reversed the previous downtrend and helped the EUR some recovery after the knee-jerk reaction. Anyway, Germany is a manufacturing powerhouse, but Brexit uncertainty may be also prompting various big banks & financials to shift to Frankfurt (Germany).

Markit noted on the flash German PMI data:

“The Germany PMI (composite) broke its recent run of successive falls in January thanks to a stronger increase in service sector business activity, but the growth performance signaled by the index was still one of the worst over the past four years”.

“Worryingly for the outlook, the recent soft patch in demand continued into the New Year. Firms are also showing greater caution towards hiring with job creation at a 25-month low, though in a historical context these are still healthy employment figures”.

“Manufacturing fell into contraction in January as the sector’s order book situation continued to worsen, showing the steepest decline in incoming new work since 2012. Weakness in the auto industry was once again widely reported, as was a slowdown in demand from China”.

“Manufacturers saw some respite in the form of weaker cost pressures, as the rate of input price inflation in the sector cooled to a 27-month low, partly due to the recent correction in oil prices. Service providers, meanwhile, highlighted the impact of wage pressures which contributed to steeper increases in both their overall costs and selling prices”.

In France, the January manufacturing PMI surged to 51.2 from prior contraction of 49.7, stronger than the expectations of 50.0. But the French service PMI for January further tumbled into a deep contraction to 47.5 from prior 49.0, weaker than the expectations of 50.6. The French composite PMI for January slid to 47.9 from prior 48.7, weaker than the expectations of 51.0 and at a 50-month low.

Markit noted on the flash French PMI data:

“Private sector firms in France reported a further contraction in output during the opening month of 2019. The latest decline was the fastest for over four years, even quicker than the fall in protest-hit December. The strong service sector that had supported a weak manufacturing sector in the second half of 2018 declined at a faster rate in January. Meanwhile, manufacturers recovered to register broadly-unchanged production”.

“Despite the continuation of ‘gilets Jaunes’ protests, it is unclear whether the latest weak performance was caused by the resulting disruption, or whether the anticipated global economic slowdown for 2019 is already beginning to take hold”.

“Although firms reported higher confidence in January, other forward-looking indicators such as new orders fell at the fastest pace for over four years. This suggests further weak performance for France in the coming months”.

Markit noted on the flash Eurozone PMI data:

“The Eurozone economy slipped closer to stall speed in January, with companies reporting the first drop in demand for over four years. The disappointing survey data indicate that GDP is rising at a quarterly rate of just 0.1%”.

“Both the manufacturing and service sectors are close to stagnation, highlighting the broad-based nature of the current slowdown. Ongoing auto sector weakness, Brexit worries, trade wars and the protests in France were again widely cited as factors dampening growth, but the survey responses indicate that a deeper malaise has set in at the start of the year. Companies are concerned about a wider economic slowdown gathering momentum, with rising political and economic uncertainty increasingly affecting risk appetite and demand”.

“The ‘yellow vest’ protests led to the steepest downturn in the French economy since November 2014, consistent with GDP falling in the first quarter if these levels continue in coming months. But German businesses are also reporting their toughest spell for four years, led by the manufacturing sector slipping into decline for the first time since 2014, in turn reflecting the largest drop in exports for six years”.

“The survey’s output and price gauges have both now fallen into territory more associated with the ECB loosening rather than tightening policy, raising pressure on the central bank to acknowledge that downside risks to the outlook now predominate.”

In the ECB Q&A and statement a few hours later after the Markit comments, Draghi indeed acknowledged that the downside risk to the Eurozone economy (slowdown) is now more predominant rather than the upside risk. Subsequently, EUR stumbled as the flash PMI data indicates that the Eurozone economy recorded its weakest growth readings since 2013.

As per a report, the German economy ministry will revise the 2019 GDP forecast to 1.0% from prior 1.8% and 1.6% in 2020. That’s a big downgrade of economic growth in the Eurozone’s largest economy and the powerhouse of Europe/EU.

On Tuesday, another data shows that the German ZEW economic sentiment for January improved to -15 from prior -17.5, higher than the expectations of -18.4. The German ZEW current conditions for January tumbled to 27.6 from prior 45.3, lower than the expectations of 43.5. For the Eurozone, the ZEW economic sentiment improved slightly to -20.9 from prior -21.0 but was lower than the expectations of -20.1.

For Germany, ZEW noted that the indicator is still well below the long-term average of 22.4. And the current economic situation once again decreased considerably:

“It is remarkable that the ZEW Economic Sentiment for Germany has not deteriorated further given a large number of global economic risks. The financial market experts have already considerably lowered their expectations for economic growth in the past few months. New, potentially negative factors such as the rejection of the Brexit deal by the British House of Commons and the relatively weak growth in China in the last quarter of 2018 have thus already been anticipated”.

Like ZEW, Draghi/ECB now also looking for a soft orderly Brexit and a sustainable trade deal between the US and China, the world’s two largest economies. Actually, the German economy is also a victim of US-China trade as-well-as Brexit politics. Germany is a big trading partner of both China and Great Britain. Thus the German political leadership (Markel) is under immense pressure from German business houses to ensure a smooth (soft) Brexit.

And Trump is also under immense pressure from global business leaders gathered at the Davos WEF to make a trade deal with China, considering the reality of the ground situation. The previous cycle of synchronized global expansion has now already turned into a vicious cycle of synchronized global contraction.

Technical View: EURUSD

Technically, whatever may be the narrative, EURUSD has to sustain above 1.13950-1.14100 for a further rally to 1.14500/1.14800*-1.15050/1.15700* and 1.16000/1.16200-1.16500/1.16900 in the coming days (under bullish case scenario).

On the flip side, sustain below 1.13800-1.13500/1.13300, EURUSD may further fall to 1.13050/1.12850-1.12600/1.12100 and 1.11900/1.11600-1.11100/1.10000 in the coming days (under bear case scenario).

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